<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------------
FORM 10-KSB/A
AMENDMENT NO. 2
/X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1996
OR
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
0-25828
--------------------
(Commission File No.)
ELECTROPHARMACOLOGY, INC.
-----------------------------------------------------------------
(Exact name of Small Business Issuer as specified in its charter)
Delaware 954315412
---------------------------- ---------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
2301 N.W. 33RD COURT, SUITE 102, POMPANO BEACH, FLORIDA 33069
(Address of principal executive offices including zip code)
Registrant's telephone number, including area code: (954) 975-9818
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. / /
The issuer's revenues for the fiscal year ended December 31, 1996 is 2,149,011.
The aggregate market value of the registrant's Common Stock held by non-
affiliates as of July 2, 1997 was approximately $4,686,450.20. As of July 2,
1997 there were 3,732,376 shares of the registrant's Common Stock
outstanding.
Documents Incorporated by Reference:
NONE
- ------------------------------------------------------------------------------
<PAGE>
AMENDMENT TO APPLICATION OR REPORT
FILED PURSUANT TO SECTION 12, 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
ELECTROPHARMACOLOGY, INC.
FORM 10-KSB/A
AMENDMENT NO. 2
FOR THE YEAR ENDED DECEMBER 31, 1996
The undersigned registrant hereby amends the following items, financial
statements, exhibits or other portions of its Annual Report on Form 10-KSB
for the fiscal year ended December 31, 1996 as set forth in the pages
attached hereto:
Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Item 7. Financial Statements.
1
<PAGE>
PART II
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company was organized in August 1990 and commenced commercially
marketing the SofPulse-TM- device in early 1992. To date, the Company has
generated only modest revenue from sales and rentals of the SofPulse-TM-,
which has achieved only limited market acceptance. Since inception, the
Company's expenses have exceeded revenue, resulting in losses of $3,069,586
and $2,927,990, respectively, for the years ended December 31, 1995 and 1996.
As of December 31, 1996, the Company had an accumulated deficit of
$13,599,257. Losses incurred since inception have been primarily attributable
to costs incurred in connection with the design and development of the
Company's products, research and clinical studies on the SofPulse-TM-,
manufacturing, marketing literature and advertisement for the SofPulse-TM-,
and the hiring of personnel necessary to support the Company's operations.
The Company continues to have high levels of operating expenses (including
salaries of management, research and development, manufacturing and marketing
personnel) and will be required to incur significant expenses in connection
with research and clinical studies and the purchase of materials to
manufacture the SofPulse-TM- devices. Once manufactured, it may take several
months for a SofPulse-TM- device to produce any rental revenue for the
Company. Accordingly, the Company anticipates that it will continue to incur
significant losses until, at the earliest, the Company generates sufficient
revenue to support its operations. The Company believes that generation of a
level of revenue sufficient to support operations is dependent upon, among
other things, the Company's ability to demonstrate successfully and
objectively SofPulse's-TM- clinical utility through controlled clinical
studies; build an effective sales and marketing infrastructure to increase
significantly the sale and rental of the SofPulse-TM- devices in the existing
and the target markets; continue to obtain reimbursement for the SofPulse-TM-
treatment by third party payors; and develop and introduce new products and
enhance existing products. There can be no assurance that the Company will
be able to achieve any of the foregoing, which could have a material adverse
effect on the Company's business, financial condition, cash flows, results of
operations and prospects.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Revenue for 1996 was $2,149,011 compared to $1,996,663 for 1995, or an
increase of $152,348. This 7.6% increase was primarily attributable to
increased SofPulse-TM- rental revenue during the last half of 1996. Revenue
growth during the first half of 1996 was adversely affected by the
reorganization of the Company's sales organization. That reorganization has
been completed and the Company began to experience improvement from those
changes beginning in October 1996. The Company then expanded its domestic
geographic coverage and contracted with four additional independent
representative organizations. As a result, during the second half of 1996,
monthly rental revenue increased from $112,000 in June 1996 to $202,000 in
December 1996, an increase of $90,000, or 80.4%. By the end of 1996, there
were 278 units under rental contracts, compared to 168 units at the end of
1995.
Revenue from the sale of units decreased 33.1% from $612,846 in 1995 to
$409,818 in 1996. The Company is placing more emphasis on expanding the
rental base of its SofPulse-TM- device.
Cost of revenue in 1996 increased $152,042 to $376,197, compared to
$224,155 in 1995. This 67.8% increase reflects additional depreciation
associated with the expanded SofPulse-TM- rental base in addition to charges
of approximately $52,000 recorded in the fourth quarter of 1996 for obsolete
SofPulse-TM- Model 911 devices.
Selling general and administrative expenses were $3,941,235 in 1996,
compared to $2,813,389 in 1995, an increase of $1,127,846, or 40.1%. This
cost increase reflects the salaries and related benefits for additional
personnel to support the Company's operations. In the first half of 1996,
the Company redirected its focus from research and development to sales and
marketing. Three full-time physical therapists, a product manager, a national
sales director and two regional sales directors joined the Company, adding to
the Company's payroll
-2-
<PAGE>
expenses. Later in 1996, Joseph Mooibroek joined the Company as its new
Chairman of the Board, President and Chief Executive Officer. (See
"Description of Business -- Recent Developments" regarding Mr. Mooibroek's
recent resignation). Mr. Mooibroek received as compensation during fiscal
1996 an aggregate of $224,404 in cash compensation, 32,903 shares of Common
Stock valued on the date of grant at $94,596, and 592,086 options to purchase
shares of Common Stock of the Company. Selling general and administrative
expenses also include fourth quarter 1996 adjustments of approximately
$251,000 primarily to increase the allowance for doubtful accounts ($56,000)
and to record legal ($67,000), consulting ($47,000) and other liabilities
($81,000) which arose in the fourth quarter. Such costs are associated with
events and transactions which occurred during 1996 and are not expected to be
recurring expenses of the Company. (See last paragraph of Note
11--Contingencies and Note 13--Fourth Quarter Adjustments in the Notes to
Financial Statements.)
Research and development expenses decreased to $815,722 in 1996, compared
to $1,690,163 in 1995, a decrease of $874,441, or 51.7%. This decrease was
primarily attributable to the completion in early 1996 of the Company's
initial clinical trials in connection with the Company's PMA application (see
"Description of Business -- Research and Development"), as well as the
reduction of basic scientific research involving PRF and PEMS-TM-
technologies. The Company incurred employment related expenses of
approximately $49,000 in connection with the hiring of Dr. Arup Sen as
Executive Vice President of Research, Development, Regulatory, and Clinical
Studies in November 1996. Dr. Sen has served as Chairman of the Board,
President, Chief Executive Officer and Secretary since April 1, 1997. (See
"Description of Business--Recent Developments" regarding Dr. Sen's recent
appointment to his current positions.)
Interest expense in 1996 decreased to $8,933 from $463,172 in 1995. This
$454,239 or 98.1% decrease resulted from eliminating substantially all
outstanding debt after the Company completed its initial public stock
offering in May 1995 and changed its capital structure by issuing Preferred
Stock and converting $1,000,000 of debt to Common Stock in November 1995.
With the exception of obligations under capital equipment leases, the Company
had no debt outstanding at December 31, 1996.
Interest income in 1996 decreased to $65,086, compared to $124,630 in
1995, a decrease of $59,544, or 47.8%. This decrease resulted from the lack
of funds of the Company available for short term investment.
As a consequence of the Company's deteriorating cash position and its
unsuccessful efforts to consummate a financing in late 1996 and early 1997,
in March 1997 the Company underwent a reduction in personnel from 27 to 18
employees, or 33%. In order to minimize the adverse effect such reduction in
personnel may have on the Company's ability to generate revenue from
marketing and sales activities, the Company has reallocated three of its
research and development personnel to provide marketing support until
additional funds are available. The Company also is focusing its sales
efforts mostly in geographic areas where the Company has achieved reasonable
market presence. The Company intends to redistribute the approximately 200
SofPulse-TM- devices in its rental fleet that are not generating sufficient
rental revenue to areas where higher utilization of the devices is expected.
The Company also has in its current inventory about 60 finished devices with
which it can fill future orders for the sale or rental of the product. If
the Company receives orders for more than the approximately 260 devices that
are being re-distributed or are in current inventory, the Company will have
to manufacture additional devices. (See "Description of the Business --
Manufacturing and Suppliers"). The Company cannot predict the results these
changes will have on its ongoing revenue and intends to replace terminated
employees and expand its operations when, and if, new financing is
consummated.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash requirements have been and will continue to be
significant. Since its inception, the Company has satisfied its operating
requirements primarily through the issuance of equity and debt securities and
loans from stockholders. At December 31, 1996, the Company had working
capital of $192,837.
Net cash used in 1996 operating activities was $2,630,218, as compared to
$3,193,078 in 1995. Net cash was used primarily to fund the losses from
operations. Net cash used in 1996 investing activities was $49,690,
-3-
<PAGE>
which was used to purchase equipment. At December 31, 1996, the Company did
not have any material commitments for capital expenditures. Net cash used in
financing activities was $166,317 for 1996, compared to $5,937,555 of cash
provided by these activities in 1995. Financing activities in 1996 included
repayment of notes payable to related parties and payments of capital lease
obligations. At December 31, 1996, the Company had cash of $223,523.
At December 31, 1996, the Company had a net operating loss ("NOL")
carryforward of $9,013,000 available to offset future taxable income, if any,
through the year 2011. In the event a 50% or greater change in ownership
occurs, a substantial annual limitation would be imposed upon the future
utilization of these loss carryforwards. At this point in time, the Company
has not completed a change in ownership study and any limitations are not
known.
Under the present circumstances, the Company's ability to continue as a
going concern depends on its ability to restructure, improve its operations,
and ultimately, to obtain additional financing. The Company has taken steps
that include reductions in operating costs, including stringent cost
controls, personnel reductions and redeployments, and the deferral of the
majority of research and development activities until after 1997. There can
be no assurance that these measures will be successful. Moreover, deferring
research and development activities will delay the development of new
products. The Company will also defer, until after 1997, conducting
definitive clinical studies that document the effectiveness of the
SofPulse-TM- treatment for its intended use. This deferral of clinical
studies may adversely affect the continued acceptance or use of the
SofPulse-TM- device and negatively affect the Company in the longer term.
However, at the present time, the Company believes these actions are
necessary to reduce near term cash requirements and to fund other operating
activities.
The Company is continuing to expand the number of SofPulse-TM- devices
that are under rental agreements generating revenue and will continue to
allocate more devices to those geographic areas where it believes it can
produce higher monthly revenue per device based on higher utilization. The
Company believes that these efforts will increase its monthly revenue,
although there can be no assurance whether sufficient revenue growth can be
achieved over the long-term.
The Company is also exploring alternative sources of additional
financing. No definitive sources of additional financing have been identified
at this time, nor can there be any assurance that additional financing will
be obtained or obtained on favorable terms. There are certain capital and
other requirements that the Company must exceed or maintain in order for the
Company's Common Stock to continue to be listed on Nasdaq. If the Company is
unable to obtain additional financing or otherwise find ways to meet its cash
requirements (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources,") the
Company will soon be in violation of the Nasdaq listing requirements and
Nasdaq may de-list the Common Stock of the Company. Accordingly, there can
be no assurance that a public trading market for the Company's Common Stock
will continue to exist.
The Company cannot predict whether the operating and financing strategies
described above will be successful. If the Company is unable to restructure
and improve its operations and is unable to ultimately obtain additional
financing, it may not be able to continue as a going concern.
-4-
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
Electropharmacology, Inc.
Audited Financial Statements
Year ended December 31, 1996
CONTENTS
Report of Independent Certified Public Accountants . . . . . . 6
Audited Financial Statements
Balance Sheet. . . . . . . . . . . . . . . . . . . . . . . . . 8
Statements of Operations . . . . . . . . . . . . . . . . . . . 9
Statements of Shareholders' Equity . . . . . . . . . . . . . .10
Statements of Cash Flows . . . . . . . . . . . . . . . . . . .11
Notes to Financial Statements. . . . . . . . . . . . . . . . .13
-5-
<PAGE>
Report of Independent Certified Public Accountants
Board of Directors
Electropharmacology, Inc.
We have audited the accompanying balance sheet of Electropharmacology, Inc.
(the Company) as of December 31, 1996 and the related statements of
operations, shareholders' equity and cash flows for the year then ended.
These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit. The financial statements of
Electropharmacology, Inc. for the year ended December 31, 1995, were audited
by other auditors whose report dated April 2, 1996, expressed an unqualified
opinion on those statements.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the 1996 financial statements referred to above present
fairly, in all material respects, the financial position of
Electropharmacology, Inc. at December 31, 1996 and the results of its
operations and its cash flows for the year then ended, in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note 2
to the financial statements, the Company incurred significant recurring
operating losses and negative operating cash flows. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans regarding these matters are also described in Note 2.
The financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classification of liabilities that might result from the
outcome of this uncertainty.
/s/ ERNST & YOUNG LLP
- -----------------------------
Ernst & Young LLP
West Palm Beach, Florida
February 9, 1997, except for the last paragraph of
Note 2, as to which the date is April 7, 1997,
the third paragraph of Note 10, as to which the
date is April 12, 1997, and the sixth paragraph
of Note 11, as to which the date is March 27,
1997
-6-
<PAGE>
Report of Independent Certified Public Accountants
The Board of Directors
Electropharmacology, Inc.
We have audited the accompanying balance sheet of Electropharmacology, Inc.
as of December 31, 1995, and the related statements of operations,
shareholders' equity (capital deficit) and cash flows of Electropharmacology,
Inc. for each of the two years in the period ended December 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations, changes in shareholders'
equity (capital deficit) and cash flows of Electropharmacology, Inc. for the
year ended December 31, 1995 in conformity with generally accepted accounting
principles.
As discussed in the Note 1 to the financial statements, to conform to a
Securities and Exchange Commission Staff position announced in March 1997,
the loss attributable to common stock was restated for 1995.
/s/ BDO Seidman, LLP
--------------------------------
BDO Seidman, LLP
Miami, Florida
April 2, 1996
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<PAGE>
Electropharmacology, Inc.
Balance Sheet
December 31, 1996
(Restated)
ASSETS
Current assets:
Cash $ 223,523
Trade accounts receivable, net of allowance
for doubtful accounts of $134,000 572,202
Inventory 94,164
Trade notes receivable 248,190
Prepaid expenses 50,127
----------
Total current assets 1,188,206
Rental and other equipment, net 945,058
Deposits and other assets 79,816
----------
Total assets $2,213,080
==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 316,746
Accrued expenses 513,130
Accrued commissions 30,845
Accrued payroll 104,701
Customer deposits 7,561
Current maturities of obligations under
capital leases 22,386
----------
Total current liabilities 995,369
Obligations under capital leases, less current
maturities 3,336
----------
Total liabilities 998,705
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value--10,000,000
authorized shares; issued and outstanding 421,950
(entitled to $2,000,043 in liquidation) 4,220
Common stock, $.01 par value--30,000,000 authorized
shares; 3,540,165 shares issued and 3,529,672
outstanding 35,402
Additional paid-in capital 14,834,010
Treasury stock, at cost, 10,493 common shares (60,000)
Deficit (13,599,257)
----------
Total shareholders' equity 1,214,375
----------
Total liabilities and shareholders' equity $2,213,080
==========
SEE ACCOMPANYING NOTES.
-8-
<PAGE>
Electropharmacology, Inc.
Statements of Operations
YEAR ENDED DECEMBER 31
1996 1995
-----------------------------
(Restated)
Revenue:
Rentals $ 1,739,193 $ 1,383,817
Sales 409,818 612,846
-----------------------------
Total revenue 2,149,011 1,996,663
Operating expenses:
Cost of revenue 376,197 224,155
Selling, general and administrative 3,941,235 2,813,389
Research and development 815,722 1,690,163
-----------------------------
Total operating expenses 5,133,154 4,727,707
-----------------------------
Loss from operations (2,984,143) (2,731,044)
Other income (expense):
Interest expense (8,933) (463,172)
Interest income 65,086 124,630
-----------------------------
Total other income (expense) 56,153 (338,542)
-----------------------------
Net loss (2,927,990) (3,069,586)
Deduct assumed dividends on convertible
preferred stock and warrants - (3,481,088)
-----------------------------
Loss attributable to common stock $(2,927,990) $(6,550,674)
=============================
Net loss per common share after deduction
for required dividends on convertible
preferred stock and warrants $ (.89) $ (2.70)
=============================
Weighted average number of common shares
outstanding 3,298,849 2,429,880
=============================
SEE ACCOMPANYING NOTES.
-9-
<PAGE>
Electropharmacology, Inc.
Statements of Shareholders' Equity
(Restated)
<TABLE>
PREFERRED STOCK COMMON STOCK ADDITIONAL TOTAL
------------------ ---------------- PAID-IN TREASURY SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCK DEFICIT EQUITY
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1995 $ 0 1,628,529 $16,285 $ 3,027,824 $ 0 $ (4,120,593) $(1,076,484)
Issuance of common stock in
connection with initial
public offering 1,250,000 12,500 5,091,457 5,103,957
Note payable to related party
converted to common stock 195,945 1,960 998,040 1,000,000
Issuance of preferred stock 421,950 4,220 1,895,780 1,900,000
Repurchase of common stock (60,000) (60,000)
Issuance of warrants to
consultant for services 214,500 214,500
Assumed dividends on convertible
preferred stock and warrants 3,481,088 (3,481,088) 0
Net loss (3,069,586) (3,069,586)
-----------------------------------------------------------------------------------------------
Balance at December 31, 1995 421,950 4,220 3,074,474 30,745 14,708,689 (60,000) (10,671,267) 4,012,387
Exercise of warrants 421,950 4,220 4,220
Issuance of common stock for
services 43,741 437 125,321 125,758
Net loss (2,927,990) (2,927,990)
-----------------------------------------------------------------------------------------------
Balance at December 31, 1996 421,950 $4,220 3,540,165 $35,402 $14,834,010 $(60,000) $(13,599,257) $ 1,214,375
===============================================================================================
</TABLE>
SEE ACCOMPANYING NOTES.
-10-
<PAGE>
Electropharmacology, Inc.
Statements of Cash Flows
<TABLE>
YEAR ENDED DECEMBER 31
1996 1995
--------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $(2,927,990) $(3,069,586)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 286,037 221,162
Amortization 3,516 310,335
Issuance of common stock and warrants for
services 125,758 214,500
Loss on disposal of office equipment 6,426 0
Provision for doubtful accounts 93,000 45,728
Discount on trade note receivable 21,982 0
Changes in operating assets and liabilities:
Trade notes receivable 273,162 (543,334)
Inventory (47,893) (139,271)
Accounts receivable (315,370) (110,007)
Prepaid expenses 14,532 (59,291)
Accounts payable 65,537 (175,870)
Accrued payroll 44,369 (24,406)
Accrued expenses, commissions and customer
deposits 194,543 85,008
Rental equipment (SofPulse-TM- units) (467,827) 51,954
--------------------------
Net cash used in operating activities (2,630,218) (3,193,078)
INVESTING ACTIVITIES
Purchases of property and equipment (32,548) (169,058)
Deposits and other assets (17,142) 15,426
--------------------------
Net cash used in investing activities (49,690) (153,632)
FINANCING ACTIVITIES
Net proceeds from issuance of preferred stock 0 1,900,000
Repayment of long-term notes payable and capitalized
lease obligations (50,537) (48,945)
Net proceeds from issuance of notes payable 0 400,000
Repayment of notes payable to related parties (120,000) (1,562,000)
Proceeds from sale of common stock 4,220 5,248,500
--------------------------
Net cash (used in) provided by financing activities (166,317) 5,937,555
--------------------------
Net (decrease) increase in cash (2,846,225) 2,590,845
Cash at beginning of year 3,069,748 478,903
--------------------------
Cash at end of year $ 223,523 $ 3,069,748
==========================
</TABLE>
-11-
<PAGE>
Electropharmacology, Inc.
Statements of Cash Flows
<TABLE>
YEAR ENDED DECEMBER 31
1996 1995
--------------------------
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest, net $ 6,596 $ 162,154
=======================
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Issuance of common stock for services $ 125,758 $ 0
Notes payable to related party converted to common
stock 0 1,000,000
Prepaid offering costs reclassified to additional
paid-in capital 0 144,543
Liability incurred for the repurchase of common stock 0 60,000
</TABLE>
SEE ACCOMPANYING NOTES.
-12-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS AND MAJOR SUPPLIERS
Electropharmacology, Inc. (the Company) was incorporated on August 31, 1990
under the laws of the State of California under the name Magnetic Resonance
Therapeutics, Inc. and reorganized through a merger with and into
Electropharmacology, Inc., a Delaware Corporation, in February 1995. The
Company is engaged in designing, developing, manufacturing and marketing
medical devices that deliver pulsed electromagnetic signals in the radio
frequency range. The Company's current product is SofPulse-TM-.
The Company is dependent on four suppliers to supply all the major components
of its products. Management believes that alternative sources are presently
available if the current supply of any of its product's components are
discontinued, limited or delayed.
REVENUE RECOGNITION
Rental revenue is recognized over the month-to-month period in which the
related equipment is under lease to a customer, primarily on a per use basis.
Sales revenue is recognized upon shipment and the transfer of ownership of
the product.
INVENTORY
Inventory, which consists of raw materials and work-in-process, is valued at
the lower of cost (average cost method) or market. Upon completion, finished
goods are transferred to property and equipment.
OTHER ASSETS
Other assets are amortized using the straight-line method and consist
principally of patent costs, amortized over 17 years from the date of
issuance of the patent.
-13-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RENTAL AND OTHER EQUIPMENT AND DEPRECIATION AND AMORTIZATION
Rental and other equipment is carried at cost. Depreciation and amortization is
computed using the straight-line method over the estimated useful lives (or
lease term if shorter life) of the related assets as follows:
Rental equipment 5 years
Leasehold improvements 3 years
Office equipment 4 to 7 years
Laboratory equipment 4 to 7 years
COST OF REVENUE
Cost of Revenue for the years ended December 31, 1996 and 1995 includes costs
associated with rental of the SofPulse-TM- units of approximately $328,000
and $172,000 respectively.
STOCK BASED COMPENSATION
The Company has elected to follow Accounting Principles Board (APB) Opinion
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations
in accounting for its employee stock options because the alternative fair
value accounting provided for under Financial Accounting Standards Board
(FASB) Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, requires
use of option valuation models that were not developed for use in valuing
employee stock options. Under APB No. 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized.
ADVERTISING COSTS
Advertising costs, included in selling, general and administrative expenses,
are expensed as incurred and were $62,000 and $36,000 for 1996 and 1995,
respectively.
USE OF ESTIMATES AND CONCENTRATION OF CREDIT RISK
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period.
Actual results could differ from those estimates.
-14-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company sells and/or rents its product to healthcare providers such as
nursing homes, hospitals and physician practices with no specific geographic
concentration and extends credit based on an evaluation of the customer's
financial condition, generally without requiring collateral. Exposure to
losses on receivables is principally dependent on each customer's financial
condition. The Company monitors its exposure for credit losses and maintains
allowances for anticipated losses.
INCOME TAXES
The Company provides for income taxes under the provisions of FASB Statement
No. 109, ACCOUNTING FOR INCOME TAXES, which requires the asset and liability
method of accounting for income taxes. Under the asset and liability method
of FASB Statement No. 109, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using the enacted tax rates expected to apply to taxable income in the years
in which those temporary differences are expected to be recovered or settled.
DIVIDENDS AND NET LOSS PER COMMON SHARE
For the years ended December 31, 1996 and 1995, options and warrants are
excluded from the computation of net loss per share because the effect of
inclusion would be antidilutive due to the Company's net operating losses.
Additional paid-in capital and deficit were restated for 1996 and 1995 and
loss attributable to common stock was restated for 1995 to reflect assumed
dividends arising from convertible preferred stock and warrants issued in
connection with the convertible preferred stock, at conversion and exercise
prices that were substantially discounted from the fair market value of the
Company's common stock at the time the convertible preferred stock and
warrants were issued.
2. LIQUIDITY AND BASIS OF PRESENTATION
The accompanying financial statements have been prepared on a going-concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities and commitments in the normal course of business.
The Company reported a net loss of $2,927,990 for the year ended December 31,
1996 and has incurred losses aggregating $10,118,169 through December 31,
1996. At December 31, 1996, the Company had working capital of $192,837 and
shareholder's equity of $1,214,375.
-15-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
2. LIQUIDITY AND BASIS OF PRESENTATION (CONTINUED)
The Company's 1997 operating plan contemplates focusing activities on
expanding rental revenue by both increasing the number of SofPulse-TM-
devices in markets where it has achieved reasonable market presence and
redeploying certain devices into markets where their expected use would be at
increased levels. It also contemplates stringent cost controls, personnel
reductions and the deferral of the majority of research and development
activities until after 1997. The Company is also exploring alternative
sources of additional financing. No definitive sources of additional
financing have been identified at this time.
The Company cannot predict whether the operating and financing plans
described above will be successful. If the Company is unable to restructure
and improve its operations and is unable to ultimately obtain additional
financings, it may not be able to continue as a going concern. If the Company
is unsuccessful in its efforts, it may be unable to meet its obligations,
making it necessary to undertake such other actions as may be appropriate to
preserve asset values.
3. INVENTORY
The components of inventory at December 31, 1996 are summarized as follows:
Work-in-process $24,940
Raw material 69,224
-------
$94,164
=======
4. TRADE NOTES RECEIVABLE
During 1995, the Company received two promissory notes in connection with the
sale of SofPulse-TM- devices. These trade notes receivable consist of the
following:
- - Three year noninterest bearing term note in the amount of $218,400 (less
discount of $27,937 at December 31, 1995), payable at $7,800 monthly,
interest imputed at 12%, collateralized by equipment sold.
- - Three year noninterest bearing term note in the amount of $392,400 (less
discount of $39,529 at December 31, 1995), payable at $16,200 monthly,
interest imputed at 12%, collateralized by equipment sold (the final four
payments will total $29,700).
-16-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
4. TRADE NOTES RECEIVABLE (CONTINUED)
In January 1997, the Company agreed to accept $248,190 in full payment of
these notes, which had an outstanding balance of $270,172 at the time of the
agreement. The notes were repaid in 1997, resulting in a discount of $21,982.
This discount was recognized in the statement of operations for the year
ended December 31, 1996.
5. RENTAL AND OTHER EQUIPMENT
A summary of rental and other equipment at December 31, 1996 is as follows:
Rental equipment $1,107,925
Leasehold improvements 68,270
Office equipment under capital lease 153,580
Office equipment 118,530
Lab equipment 69,763
----------
1,518,068
Less accumulated depreciation and amortization (573,010)
----------
Net rental and other equipment $ 945,058
==========
6. INCOME TAXES
As of December 31, 1996, the Company has net operating loss carryforwards of
approximately $9,013,000 available to offset future taxable income. Such
carryforwards, which may provide future tax benefits, expire as follows:
2008--$1,206,000; 2009--$2,064,000; 2010--$2,901,000; 2011--$2,842,000. It
appears that a change in ownership of greater than 50% may have occurred as a
result of the Company issuing equity securities. As a result, a substantial
annual limitation may be imposed upon the future utilization of its net
operating loss carryforwards. At this point in time, the Company has not
completed a change in ownership study and the exact effects of any such
limitations are not known.
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<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
Significant components of the Company's deferred income taxes at December 31,
1996 are as follows:
Net operating loss carryforwards $ 3,392,000
Other, net 158,600
-----------
Deferred tax assets 3,550,600
Deferred tax liabilities--equipment (75,300)
-----------
3,475,300
Less valuation allowance (3,475,300)
-----------
Net deferred tax assets $ 0
===========
The net change in the valuation allowance for the year ended December 31,
1996 was an increase of approximately $1,075,300.
Income tax expense differs from the expected rate for the year ended
December 31, 1996, primarily as a result of excluding benefits related
to net operating loss carryforwards because of the uncertainty of their
realization at this time.
7. SHAREHOLDERS' EQUITY AND WARRANTS
On November 1, 1996, the Company's stockholders approved proposals to
increase the Company's authorized capital stock from 10,000,000 to 30,000,000
shares of $.01 par value common stock and from 1,000,000 to 10,000,000 shares
of $.01 par value preferred stock.
On May 12, 1995, the Company consummated its initial public offering of
securities on the NASDAQ SmallCap Market and sold 1,250,000 shares of common
stock at $5.00 per share. Additionally, 718,750 redeemable warrants to purchase
common stock were issued and sold for $.10 per warrant. Each warrant entitles
the registered holder thereof to purchase one share of common stock at a price
of $6.00, subject to adjustment in certain circumstances, at any time commencing
June 12, 1996 through May 12, 1998. Net proceeds of this offering, after the
underwriter's commissions and all expenses, were $5,103,957.
For an aggregate of $187.50, the underwriter was issued warrants to purchase
125,000 shares of common stock at $7.00 per share and 62,500 warrants to
purchase warrants at $.14 each to purchase common stock at $6.00 per share.
No warrants have been exercised.
-18-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
7. SHAREHOLDERS' EQUITY AND WARRANTS (CONTINUED)
During June 1995, the Company issued warrants to purchase 30,000 shares of
common stock at $4.00 per share and 12,000 shares of common stock at $5.25
per share to consultants of the Company for certain investor relations work.
Each of these warrants vested immediately and expires in five years. Further,
a four-year warrant to purchase 25,000 shares of common stock at $5.25 per
share was issued to a consultant to the Company for certain scientific
contributions to the Company. No warrants have been exercised.
In November 1995, in consideration of $2,000,000, the Company issued to an
investor (i) 421,950 shares of Series A Convertible Preferred Stock (the
Preferred Stock) and (ii) warrants to purchase an aggregate of 1,721,950
shares of common stock. In connection with the transaction, the Company paid
a $100,000 commission to two investment bankers and issued five-year warrants
to purchase 100,000 shares of common stock at an exercise price of $5.50 per
share.
Each share of Preferred Stock is convertible at a conversion price of $4.74
per share which was at a discount from the market price of $6.50 per share,
at the option of the holder, into one share of common stock, subject to
adjustment in certain circumstances, at any time until November 13, 2000, at
which time outstanding shares of Preferred Stock automatically convert into
common stock. Shares of Preferred Stock have votes equal to those of common
stock into which they are convertible and, subject to certain exceptions and
except as required by law, vote together with the common stock as a single
class. The Preferred Stock votes as a single class on certain matters
including the incurrence of secured indebtedness by the Company, changes in
the number and the terms of the directors of the Company and the issuance of
cash dividends and redemptions or repurchase of securities by the Company.
The Preferred Stock is entitled to receive noncumulative cash dividends,
when, as and if declared by the Board of Directors of the Company and has a
liquidation preference of $4.74 per share.
The warrants consist of warrants to purchase: (i) 421,950 shares of common stock
at an exercise price of $.01 per share; (ii) 800,000 shares of common stock at
an exercise price of $6.00 per share; (iii) 250,000 shares of common stock at an
exercise price of $7.50 per share; and (iv) 250,000 shares of common stock at an
exercise price of $9.00 per share. The warrants are exercisable at any time
until November 13, 2005. The exercise price and number of shares issuable upon
exercise of the warrants are subject to adjustment in certain circumstances,
including the issuance of securities for a price less than the current market
value of the common stock. In June 1996, for proceeds to the Company of $4,220,
the investor exercised 421,950 warrants to purchase common stock at an exercise
price of $.01 per share.
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<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
7. SHAREHOLDERS' EQUITY AND WARRANTS (CONTINUED)
In November 1995, a family member of an officer and current member of the
Board of Directors of the Company, converted an aggregate of $1,000,000
principle amount of promissory notes into 195,945 shares of common stock. In
consideration for such conversion, the Company granted five-year warrants to
purchase 300,000 shares of common stock at a price of $6.25 per share,
subject to adjustment in certain circumstances. Subject to certain
limitations and exclusions, the Company agreed to include the shares
underlying the warrants in an appropriate registration statement filed by the
Company. No warrants have been exercised.
In December 1995, five-year warrants to purchase 65,000 shares of common
stock at $1.00 were issued to a consultant of the Company as full
consideration for a three-year financial consulting agreement. The Company
recorded an expense of $214,500 in connection with this transaction. Also,
five-year warrants to purchase 100,000 shares of common stock at $5.79 per
share were issued to a management consultant to the Company. No warrants have
been exercised.
In December 1995, the Company repurchased 10,493 shares of common stock for
$60,000 in connection with the resignation of the Company's chief operating
officer.
In December 1996, the Company issued 43,741 shares of common stock to
officers of the Company in lieu of cash for payment of outstanding employment
related liabilities.
The Company currently has 421,950 shares of Class A Preferred Stock and
3,540,165 shares of common stock issued and outstanding. Further, warrants to
purchase an aggregate of 3,012,707 shares of common stock have been issued to
date. With exception of the 421,950 warrants exercised in June 1996, no
warrants have been exercised.
At December 31, 1996, shares of the Company's authorized but unissued common
stock were reserved for issuance as follows:
NUMBER OF
SHARES
----------
Exercise of warrants 3,012,707
Employee stock option plans (see Note 8) 1,113,860
Convertible preferred stock 421,950
----------
4,548,517
==========
Such exercise and conversion would result in gross proceeds of $33,343,211.
-20-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
7. SHAREHOLDERS' EQUITY AND WARRANTS (CONTINUED)
Effective November 1, 1996, the Board of Directors approved an Employee Stock
Purchase Plan (ESPP) covering all employees who meet service period
requirements. The ESPP provides for the sale of common stock to employees of
the Company at a price equal to 85% of the lesser of the market value at the
end of or beginning of each respective quarter. No shares have been issued
under the ESPP during 1996 as the plan is pending shareholder approval.
Effective January 1, 1996, the Company established the Electropharmacology,
Inc. 1996 Non-Employee Director's Equity Compensation Plan (the Compensation
Plan). The Compensation Plan provides for the issuance of common shares as
compensation for serving as a director of the Company. No shares were issued
under the Compensation Plan during 1996.
8. STOCK OPTIONS
The Company has adopted a stock option plan which was amended on November 1,
1996 (the Plan) for officers, directors, employees and consultants. Under the
Plan, the options granted may be either "incentive stock options" (for
officers and employees only) within the meaning of Section 422A of the
Internal Revenue Code, and/or nonqualified stock options (for officers,
employees, directors and consultants). The exercise price of incentive stock
options may not be less than 100% of the fair market value of the Company's
common stock as of the date of grant (110% of the fair market value if the
grant is to an employee who owns more than 10% of the outstanding common
stock). Nonqualified stock options may be granted under the Plan at an
exercise price less than fair market value of the common stock on the date of
grant.
As of December 31, 1996, the Board of Directors has authorized the granting
of options for up to 1,500,000 shares of common stock. Grants of options to
purchase 1,113,860 common shares, (1,043,860 of which are considered
incentive stock options), have been formalized under the Plan. The options
generally vest with a range from immediately to ratably up to five years on
differing vesting schedules. The aggregate proceeds to the Company upon
exercise of all options vested (incentive stock options and nonqualified
stock options, respectively) as of December 31, 1996 is $1,906,826. The
aggregate proceeds to the Company upon exercise of all options outstanding as
of December 31, 1996 is $5,543,616. The options expire at dates ranging from
two to ten years after date of grant.
-21-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
8. STOCK OPTIONS (CONTINUED)
As required by Statement No. 123, pro forma information regarding net income
and earnings per share has been determined as if the Company had accounted
for its employee stock options under the fair value method of that statement.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1996: risk-free rate of return of 5.200%; dividend yield of
0.000%; volatility factor of the expected market price of the Company's
common stock of .775 and a weighted-average expected life of the options of
ten years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate,
the existing models, in management's opinion, do not necessarily provide a
reliable single measure of the fair value of its employee stock options.
Transactions under the Plan are summarized as follows:
WEIGHTED
AVERAGE
NUMBER EXERCISE
OF PRICE PER
SHARES SHARE
------- ---------
Outstanding January 1, 1995 203,712
Exercised 0
Expired 0
Forfeited 0
Canceled (99,438)
Granted 87,500
---------
Outstanding December 31, 1995 191,774 $4.87
Exercised 0 0
Expired 0 0
Forfeited 0 0
Canceled (37,000) $8.09
Granted 959,086 $5.12
---------
Outstanding December 31, 1996 1,113,860 $4.98
========= =====
-22-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
8. STOCK OPTIONS (CONTINUED)
Exercisable at December 31, 1996 397,985
=======
Reserved for future option grants at
December 31, 1996 386,140
=======
Weighted average for fair value of options
granted during 1996 $4.26
=====
FASB Statement No. 123 requires disclosure of the weighted average exercise
prices for the current year only in the initial year of adoption.
For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's 1996 and 1995 pro forma information follows:
1996 1995
----------- ------------
Net loss $(3,665,506) $(3,109,269)
=========== ===========
Loss per common share $ (1.11) $ (1.28)
=========== ===========
The 1996 pro forma effect on net loss is not necessarily representative of
the effect in the future years because it does not take into consideration
pro forma compensation expense related to grants made prior to 1995.
The exercise price of options outstanding at December 31, 1996, ranged
between $2.875 and $6.375. The weighted-average remaining contractual life of
those options for 1996 is 7.8 years.
9. LEASE COMMITMENTS
The Company leases certain office equipment and administrative facilities on
a month-to-month basis. The administrative facilities are leased at a monthly
rate of $3,300 under a three-year agreement which expires on March 31, 1997.
Rent expense under operating leases approximated $62,475 and $51,083 for the
years ended December 31, 1996 and 1995, respectively.
The Company leases certain equipment under capital leases expiring in July
1998.
-23-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
9. LEASE COMMITMENTS (CONTINUED)
Future minimum lease payments under capital leases are as follows:
Year ending December 31,
1997 $23,440
1998 3,706
--------
Total minimum lease payments 27,146
Less amount representing interest (1,424)
Less current maturities (22,386)
--------
Long-term obligations $ 3,336
========
10. EMPLOYMENT AGREEMENTS
As of December 31, 1996, the Company has employment agreements with certain
executive officers, the terms of which expire at various times through
December 31, 2001.
The President of the Company (the "President") had a five year employment
agreement expiring on August 4, 2001 which provided for a current annual base
salary of $275,000, one-fourth of which could be deferred and/or paid in
stock, at the Board's discretion, an annual increase in the base salary tied
to the Consumer Price Index, and options to purchase up to 592,086 shares of
common stock at an exercise price of $5.50 per share. The agreement also
provided that, upon the exercise of certain warrants owned by another
shareholder of the Company, the Company would grant the President an option
to purchase 10% of the number of shares acquired upon the exercise of such
warrants by such shareholder. The agreement also provided that if the
President's employment was terminated other than for cause, he would receive
an amount equal to the sum of the highest annual base salary and the average
annual bonus received by him and that he would continue to receive benefits
pursuant to the Company's welfare programs and perquisite programs for a
period of two years.
The President resigned on April 1, 1997. As of April 12, 1997, the Company and
the President entered into a severance agreement that provides, among other
things, a settlement of all rights under his employment agreement with the
Company, a cash payment by the Company of $128,700 over approximately five
months, the issuance of 5,555 shares of common stock of the Company that were
assigned to the President in lieu of a portion of his salary during 1996, the
grant to the President of a ten-year warrant to purchase 25,000 shares of common
stock of the company at $2.25 per share and the cancellation of 384,850 options
to purchase shares of common stock of the Company that were previously granted
to the President, leaving the
-24-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
President with 207,236 fully vested options to purchase shares of common
stock of the Company. The severance agreement also provides for the
cancellation of the President's right to be granted an option to purchase
one-tenth of the number of shares of common stock of the Company as to which
the shareholder referred to above exercised his warrants. The President
further agreed to assign to the Company patent protection on inventions made
by him and to cooperate with the Company in obtaining such patent protection.
The Executive Vice President of Corporate Development of the Company has an
employment agreement expiring on December 31, 2001, which provides for a
current annual base salary of $139,000 and options to purchase up to 100,000
shares of common stock at an exercise price of $5.50 per share. The agreement
also provides that if employment is terminated other than for cause, this
individual will receive an amount equal to the sum of his annual base salary
and the average annual bonus received by him and that he will continue to
receive benefits pursuant to the Company's welfare programs and perquisite
programs for a period of one year.
The Executive Vice President of Research and Development of the Company has
an employment agreement expiring on December 31, 1999 which provides for a
current annual base salary of $180,000, one third of which may be deferred
and/or paid in stock, at the Board's discretion, an annual increase in the
base salary tied to the Consumer Price Index, and options to purchase up to
75,000 shares of common stock at an exercise price of $4.75 per share. The
agreement also provides that if employment is terminated other than for
cause, this individual will receive an amount equal to the sum of his annual
base salary and the average annual bonus received by him and that he will
continue to receive benefits pursuant to the Company's welfare programs and
perquisite programs for a period of one year.
The Chief Financial Officer of the Company has an employment agreement
expiring on December 31, 1997 which provides for a current annual base salary
of $75,000, one third of which may be deferred and/or paid in stock, at the
Board's discretion and options to purchase up to 30,000 shares of common
stock at an exercise price of $2.875 per share. The agreement also provides
that if employment is terminated other than for cause, this individual will
receive an amount equal to the sum of his annual base salary and the average
annual bonus received by him and that he will continue to receive benefits
pursuant to the Company's welfare programs and perquisite programs for a
period of one year.
For the year ended December 31, 1996, approximately $37,000 of compensation
was paid in common stock.
-25-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
11. CONTINGENCIES
PROPOSED FEDERAL FOOD AND DRUG ADMINISTRATION REGULATIONS
The Company and its products are regulated by the Federal Food and Drug
Administration (the "FDA") which has determined that the Company's products
are Class III medical devices. In April 1994, the FDA proposed the adoption
of new regulations requiring the submission of premarket approval (the PMA)
applications for Class III medical devices.
The Company believes that such proposed regulations, if adopted, could require
a PMA submission in 1998 for continued marketing of the SofPulse-TM- device
although significant additional events need to occur prior to enactment and
enforcement of such new regulations. In addition, the Company will be
provided an opportunity to seek reclassification of its device to Class II.
The PMA requires medical device manufacturers to provide information
establishing the safety and effectiveness of medical devices based on
controlled trials. The PMA process is lengthy, expensive and complex, and
will require the submission to the FDA of substantial clinical data and
statistical analysis demonstrating significant effects. The Company plans to
conduct new clinical trials, as the basis for seeking a PMA from the FDA for
its SofPulse-TM- device, but there can be no assurance that the Company will
be able, for financial or other reasons, to successfully complete required
studies and file its PMA application on a timely basis, or at all.
Failure to file a PMA application within 90 days following the adoption of
final regulations by the FDA, or failing to be granted a reclassification of
the Company's device to Class II by the FDA would result in the revocation of
the Company's Section 510(k) approval and otherwise prevent the Company from
marketing and, consequently, generating any revenue from sales or rentals of
the SofPulse-TM- in the United States until a PMA application is filed and
approved by the FDA. The inability to file and obtain a PMA approval, if and
when required by the FDA, and the inability to obtain reclassification to
Class II would have a material adverse effect on the Company, including
possibly requiring the Company to significantly curtail its operations.
The Company believes that it is taking reasonable measures in order to
maintain its right to continue to market its product in the United States for
the foreseeable future.
LITIGATION
In August 1994, a competitor of the Company filed a lawsuit against the Company
and certain of its present and former directors and officers alleging the
defendants had engaged in deceptive acts and practices, false advertising,
unfair competition, breach of contracts of fiduciary duties between the
plaintiff and certain of the Company's employees, and the Company's involvement
-26-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
in facilitating or participating in the breach of contracts. The plaintiff is
seeking an injunction to rectify the effects of the misconduct, an
unspecified amount of compensatory damages, disgorgement of profits, treble
damages, punitive damages and attorney's fees. The plaintiff also seeks
unspecified injunctive relief prohibiting the Company from engaging in the
alleged acts and ordering the defendants to take remedial action to rectify
the effects on consumers and the plaintiff caused by the alleged acts.
Although the Company believes that it has meritorious defenses which it will
pursue vigorously, there can be no assurance that the ultimate outcome of
such action will not have a material adverse effect on the Company's
liquidity, financial condition and results of operations. As of December 31,
1996, the Company has not accrued any loss contingencies or related expenses
in connection with this lawsuit.
On March 27, 1997 a former distributor for the Company filed a complaint
against the Company and other defendants alleging, among other things,
misappropriation of trade secrets, breach of fiduciary duty, unfair business
practices, tortious inducement to breach contracts, tortious interference
with prospective economic advantage and breach of contract. The plaintiff
seeks unspecified damages, restitution and an injunction prohibiting the
defendants from contacting or doing business with the plaintiff's customers.
Although the Company believes that it has meritorious defenses which it will
pursue vigorously, there can be no assurance that the ultimate outcome of
such action will not have a material adverse effect on the Company's
liquidity, financial condition and results of operations. As of December 31,
1996, the Company has not accrued any loss contingencies or related expenses
in connection with this lawsuit.
Management is unable to make a meaningful estimate of the likelihood or
amount or range of loss that could result from an unfavorable outcome of the
pending litigation. It is possible that the Company's results of operations
or cash flows in a particular quarter or annual period or its financial
position could be materially affected by an unfavorable outcome.
Other claims have been asserted by various claimants. The claims are in
various stages of processing and may ultimately be brought to trial. Based on
discussions with counsel, management has accrued its best estimate of the
ultimate expense of these contingent losses.
12. FINANCIAL INSTRUMENTS
The carrying amount of financial instruments including cash, accounts
receivable, notes receivable from customers and accounts payable approximate
fair value as of December 31, 1996 because of the short maturity of these
items.
-27-
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
13. FOURTH QUARTER ADJUSTMENTS
Certain adjustments were recorded in the fourth quarter of 1996 which
included adjustments to provide allowances for doubtful accounts and
inventory shrinkage as well as adjustments to record consulting, legal and
employment related liabilities which arose in the fourth quarter. These
adjustments resulted in charges against operations aggregating approximately
$352,000.
-28-
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this Amendment No. 2 to the Registrant's
Annual Report on Form 10-KSB/A to be signed on its behalf by the undersigned,
thereunto duly authorized.
ELECTROPHARMACOLOGY, INC.
Dated August 18, 1997
By: /s/ DR. ARUP SEN
------------------------------------
Dr. Arup Sen
Chief Executive Officer
-29-
